UPDATED: A federal appeals court panel ruled Wednesday that Google did not infringe the copyrights of an adult photo publisher by displaying thumbnails of proprietary pictures in its image search engine.

But while the ruling was hailed by advocacy groups as a victory for the so-called "fair use" doctrine and for the future of innovation on the Internet in general, the panel sent parts of the case back to the lower court for further litigation.

The original suit was brought by Perfect 10, a California firm that publishes a print magazine and a subscription-only Web site featuring exclusive photos of nude models. The company sued in November 2004, claiming Google's image search engine displayed thumbnails of Perfect 10 models' photos and provided links to full-size images  most of which were actually illegally republished on pirate sites.

The lower court judge agreed and, last February, ordered Google and Amazon's A9.com subsidiary  which was also sued -- to work with Perfect 10 to come up with a preliminary injunction aimed at balancing the rights of copyright holders with the value of helping people find information.

That changed with Wednesday's ruling by a three judge panel of the 9th U.S. Circuit Court of Appeals, however.

"We reverse the district courts ruling and vacate the preliminary injunction regarding Googles use of thumbnail versions of Perfect 10s images," said judge Sandra Ikuta, writing for the three judge panel. The ruling was posted by public interest group Public Knowledge on its Web site.

The appeals court found that the thumbnails did not infringe Perfect 10's copyrights because they were "highly transformative" - that is significantly different than the full-sized images -- and thus fit into the Digital Millennium Copyright Act's (DMCA) "fair use" exception.

The term defines situations wherein a copyrighted work, or portions of it, can be legally used in a highly modified fashion without infringing the original copyright owner's rights  a classic example is a parody, Corynne McSherry, an attorney for the Electronic Frontier Foundation (EFF), told internetnews.com. (The EFF filed a friend of the court brief in the case in support of Google).

"Overall, this is a win for the Internet, particularly for 'fair use' and it's something we think the 9th Circuit got right," McSherry said, adding, "They said that the thumbnails were even more transformative than parodies . . . . [and] I was particularly pleased that the court paid attention to the public benefit of search engines."

Not surprisingly, Google officials hailed the ruling as well.

"We are delighted that the court affirmed long-standing principles of 'fair use,' holding that Google's image search is highly transformative by creating new value for consumers," Google general counsel Kent Walker said in a statement e-mailed to internetnews.com.

Public Knowledge representatives also applauded the ruling. "Although the decision didn't appear to break new legal ground, we are very pleased that the lower court was reversed and that the 'fair use' doctrine was applied correctly to Google," a Public Knowledge spokesperson said in a statement e-mailed to internetnews.com.

However, the suit is far from over. Google still faces arguments that it contributed to infringement of Perfect 10's intellectual property. The case has been a long and complex one so far and is not likely to get simpler any time soon.

"Were still taking a close look at the opinion, Russell Frackman, an attorney with one of Perfect 10s law firms, Mitchell, Silberberg & Knupp LLP, told internetnews.com. Obviously, were focused on the contributory infringement question, he added.

Still to be decided are questions as to whether Google had clear knowledge of infringement, could have taken simple measures to cure the problem, and failed to take those steps, said EFF's McSherry.